How exactly is Japan going to pay debt once its population starts to fall; once the ratio of its working population falls to a level where it can’t possibly earn enough to fund its retired population? There is a way, but few have dared speak it. How about if Japan’s central bank bought government bonds at a rate of zero yield, with an infinite maturity date? And what would happen if the Bank of England and the Fed, and most certainly the ECB, were to go for a similar option? That is to say opt for the monetisation of debt?
Writing in the ‘Telegraph’ the other day, Ambrose Evans-Pritchard joined a slowly growing list of economists and economic writers who have dared to suggest it. He actually put it more colourfully: “Let the Bank of Japan buy a nice fat chunk of this debt, heap the certificates in a pile on Nichigin Dori St in Tokyo, and set fire to it.” Or he said to “preserve appearances, you could switch the debt into zero-coupon bonds with a maturity of eternity.” See: Just set fire to Japan’s quadrillion debt
Received wisdom says governments cannot print debt away, because the result would be hyperinflation. But suppose, just suppose that the danger is deflation; that no matter what the government does, as has been the case in Japan, inflation just won’t happen. In that case why not turn on the money printing press?
The very idea fills many with horror. What about moral hazard, they say? What about the incentives to save? Such action will surely encourage reckless borrowing.
But don’t go so fast. This idea has merit, let me explain why.
Before that, let me detour for a paragraph. There is a theory doing the rounds – I call it the fiat money conspiracy theory – that the current way in which the banking system works is the cause of most of today’s ills. See, for example this link .The theory seems to have supporters on both the right and left of the political spectrum. On the right they say the money we have today is not real; it needs to be replaced by something hard, such as gold. Then banks cannot go on creating money out of nothing and serving no one but their own selfish interests. On the left, it is said that the problem with fiat money is that the money supply is boosted by creating debt. The economy is not sustainable because growth can only occur via debt, and the solution lies in printing money, and giving it away. There are lots of other theories standing somewhere between these extreme points. But they all build on the idea that banks create money via what is called fractional reserve banking through their lending and that this is somehow wrong.
Okay let me return to the thrust of this article.
There is a point that those who use the moral hazard argument against printing debt away forget. GDP, as I have said here before, equals consumption, plus investment, plus government spending, plus exports, minus imports. But for the global economy exports equals imports. Government spending does in fact fall into one of two categories; it is either consumption or investment. So for the global economy GDP equals consumption plus investment. GDP also equals income. Income equals consumption plus savings. In other words, by definition savings equals investment.
So what happens if people decide they want to save more, but there is no rise in investment? The answer is that either the rise in savings funds loans to others to fund their consumption or we see a fall in GDP.
Those who use the moral hazard argument say savings are good, and debt is bad. Don’t reward those with debt.
But this is wrong. It is not savings that are good, it is investment. And for a mature economy that is just about making full use of existing innovations, there is even a case to say investment is not very helpful.
In short, there are conditions when savings are not a good thing for the economy. A way has to be found to ensure that either investment rises, or that savings fall, and spending increases.
Every time the Bank of England makes noises about keeping interest rates low, savers cry foul.
But the anti QE lobby – those who call for higher interest rates – can’t get their head around these simple concepts. Sometimes, and let me emphasise this, it is not always this way; saving is not good for the economy. Sometimes saving can be a good thing, but the savings are not being used effectively and instead of funding investment, they fund mortgages, and consumer debt.
And that is why I believe there are occasions when printing debt away can be justified.
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